Shareholder breaches are always something that a company wants to avoid, but they do happen, and they have the potential to cause unrest at board level and financial loss to the business.
The best way to protect against potential breaches is by drawing up a shareholders agreement, so that everything is set out clearly from the outset and potential issues are tackled early.
In this article, Corporate & Commercial Solicitor Zoe Watson outlines how shareholders agreements work and how to mitigate and tackle shareholder breaches.
What is a Shareholders Agreement?
A shareholders agreement is a legally binding contract made between the shareholders of the company to govern their relationship going forward.
Although the company’s articles of association will help to some extent, a fully considered and well drafted shareholders agreement can act as a safeguard and give shareholders more protection against problems arising.
The process of putting the agreement in place gives the shareholders an opportunity to discuss and create a framework for dealing with decisions that may be more controversial as the business grows - such as profit retentions and dividend policies.
Without an agreement in place, shareholders will have to rely on the provisions of the Companies Act 2006 which may be inappropriate or inadequate for their specific requirements. It is worth bearing in mind that the Act gives little power to individual minority shareholders who are not also appointed as directors of the Company.
Typically, a shareholders agreement of this sort will set out each shareholder’s rights and obligations; this can be really useful to refer to if a breach does occur.
Related: What to include in shareholders agreement
What happens if you breach a shareholders agreement?
If a shareholder breaches the terms of an agreement, perhaps by not meeting their obligations or by using their position to implement a decision without the agreement of the majority of shareholders, it can cause problems for the other shareholders and the company as a whole.
A breach can not only put a strain on the relationship between shareholders, but also cause the other shareholders to lose their trust in the person who breached the agreement.
Depending on the type of breach and its severity, the day-to-day operations of the business could be affected and even halted. The breach in question could, for example, cause financial uncertainty or prevent the company from meeting a client’s needs.
Lastly, and arguably most crucially from a long-term standpoint, a shareholder breach could lead to concerns from employees and the other shareholders and the company’s reputation being jeopardised.
What is the remedy for breach of shareholder agreement?
If a shareholder has breached their contract there are remedial options available. These options mainly depend on the terms of the shareholders agreement, but include:
Claiming damages
If the other shareholders have suffered financial loss as a result of the breach, they may be able to claim damages.
The amount they will be able to claim will likely be equal to the amount they have lost or would have gained had the shareholder not caused a breach. This will be decided in court.
The threat of a claim for damages can act as a deterrent for shareholders who are considering acting in manner which breaches their agreement.
However, damage claims can be a long and arduous process for the aggrieved shareholders and recovery of all losses and expenses is not guaranteed.
Transfer of shares
Shareholders may be able to seek a transfer of shares from the offending shareholder to the others, depending on the terms of the agreement and the severity of the breach.
When included, a provision of this nature would act as a strong deterrent for any shareholder who may be considering violating the agreement.
A mandatory transfer of shares upon breach is often included in an agreement, or, in exceptional cases a court judgement could be obtained to force a guilty shareholder to transfer their shares.
Negotiating exit terms
Where the offending shareholder is employed, either as a director or an employee, and the board of directors decide that the shareholder can no longer work for the company, a ‘without prejudice’ discussion can take place to discuss exit terms.
A ‘without prejudice’ discussion means that if nothing is agreed to, anything said during the conversation cannot be legally used to prejudice any person involved and their position in any additional legal proceedings.
These discussions should follow a specific format and should never be undertaken unless specific legal advice has first been sought.
If a discussion of this sort is unsuccessful, Court involvement may be needed.
Specific Performance
A Court can enforce that the offending shareholder is to perform their duty, that they neglected in the breach.
This option isn’t always suitable, as the breach may not be that the shareholder didn’t perform their duty. For example, specific performance wouldn’t work where a shareholder made a financial decision independently without consultation.
Can a shareholder take action against a director?
If the offending shareholder is also a director, there are legal actions that can be taken. However, a claim may have to be brought by the company rather than the other shareholders.
It might be possible for the shareholder to take action and seek remedy on behalf of the company, but this depends on many factors and individual circumstances.
In situations where a director-shareholder uses their directorial powers to the detriment of other shareholders (unfair prejudice), a Court, under the Companies Act 2006, might enforce that the offending party takes certain action or has their shares bought.
Related: Can a director be personally liable for company debts?
For more tailored advice, please get in touch below.
Specialist Shareholder Breach Solicitors
If you have any questions following this article, or would like some tailored advice on shareholder agreements or breaches, please don’t hesitate to get in touch with our bright team.
Our team have experience in drafting effective and legally sound shareholder agreements and assisting in solving shareholder breaches to ensure the best outcome for you and your company.
You can call us on 01202 499255, or fill out the form at the top of this page, for a free initial consultation with our bright team.
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